Thursday, August 6, 2009

Assorted Musings

Here are some more assorted musings

Since there are plenty of critical pieces on the economic policies of President Barrack Obama and Fed chairman Ben Bernanke, I think it is only fair to take a look at a few articles that discuss their performances in a balanced manner. To that end here is Jeff Frankel evaluating the Obama administration and here is Thomas Cooley apprasing the Bernanke Fed. Important points that come out from these pieces is that (1) one must consider worse alternative outcomes that could have emerged had certain policies not been adopted and (2) it is only reasonable to expect some policy mistakes be made in policy making when one is the heat of battle with little time to deliberate.

As I have noted before, the Fed has some real challenges ahead of it once the recovery starts. Two recent Financial Times (FT) articles highlight some of these looming challenges. First, the FT reported that a large part of Wall Street's recent success is due to its trading with the Fed. These big banks apparently are selling overpriced securities to the Fed. The Fed is allowing this to happen to keep credit markets from freezing up. My question is how will these credit markets ever get weaned from the Fed? Second, the FT in another piece noted that in order for Bernanke to flawlessly execute his exit strategy he will need to have a good measure of the output gap. This metric, however, is not easy to measure, especially so during times of structural change such as the present. Some have argued this was one reason the Fed messed up on the 1970s--it misread the output gap and as a result was too expansionary. Will the Fed get it right this time?

Dr. Doom (i.e. Nouriel Roubini) becomes Dr. Optimistic in this article where he looks at countries that are doing relatively well given the global recession. A key characteristic he finds among these countries is that they strove to balance their budgets over the business cycle. That is they ran policy such that they saved during the boom years so that they could more easily run accommodative policies during the bust years.

Richard Thaler has an interesting Op-Ed in the Financial Times discussing how this crisis should be one of the final nails in the coffin of the efficient market hypothesis (EMH). He makes this point specifically with regards to the EMH implication that asset prices fully reflect all information and provide accurate signals about the fundamentals behind the assets. He noted that now that we have had the Japanese asset bubble in the late 1980s and the U.S. asset bubbles in the late 1990s and mid 2000s, the hard-core advocates of EMH have a lot of explaining to do:

So where does this leave us? Counting the earlier bubble in Japanese real estate, we have now had three enormous price distortions in recent memory. They led to misallocations of resources measured in the trillions and in the latest bubble, a global credit meltdown. If asset prices could be relied upon to always be "right", then these bubbles would not occur.